Howey Test And ICO Regulation In US

The Howey test is used to determine whether a transaction qualifies as an investment contract. Today, it also applies to investing in cryptocurrency. If a certain agreement is considered as an investment contract, The Securities Act of 1933 enters into force. As securities, investment contracts must be registered with the SEC. Today, the SEC is also responsible for the cryptocurrency market regulation in the United States. So when it comes to the ICO regulation, the Howey test is also aimed to define the nature of digital assets.

The Howey Test Background

The Howey test was created by the Supreme Court of the United States in 1946. The precedent was set by the legal proceeding between the SEC and W.J. Howey Co., an agricultural farm that offered leaseback agreements. Half of the company’s lands were sold to non-agrarian people who were supposed to lease these lands back to The Howey Company. The agreement assumed that the owners' profit entirely depends on the harvest received by the firm.

The Securities and Exchange Commission considered the agreement an investment contract. The reason was the passive interest of nominal owners: their profits didn't depend on their actions but on the actions of the third party. The SEC decided that The Howey Company violated the law by not registering the transaction. This was the reason for the lawsuit.

The further trial in the District and then in the Supreme Court led to the need to create a test that would help to avoid such situations in the future. The Howey Company lost that case, but its name became well known throughout the US.

How is the Howey test applied?

The Howey test consists of four basic blocks of questions that determine the following conditions:

Is there a fact of investment?

Do investors expect an investment profit?

Is the investment a common enterprise?

Does the profit depend on the actions of a third party?

Each answer is rated at a certain number of points, from -100 to 100. Then the points are added up. The more points in the end, the higher chanсes that an investor acquires a security by investing money. This means that the company must register all transactions with the SEC. The registration involves the provision of information about the management of the company and independent financial statements. Also the company must provide a description of its business model, in which it offers a deal to investors.

Initially, an investment was interpreted as referring to money. But later, other types of assets were recognized, too. Now the Howey test is also used to assess digital assets — ICO tokens. The test determines whether the crowdsale can work in the US legal terrain. The American ICO market is the largest in the world and the most demanding from the legal point of view. The Howey test was somewhat modified for the ICO regulation.

There are several types of tokens that can be purchased during an ICO campaign, but only a part of them can be considered securities. There were cases when companies tried to disguise securities to avoid registering transactions with the SEC. However, the Howey test was created precisely to show the very nature of contracts, regardless of what it is called. Therefore, the SEC examines each case on its individual merits. That is why some companies prefer not to work with the US market at all.

In the next article we will find out how to pass the Howey test and successfully launch an ICO campaign in the US.

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